Macroeconomics

F I G U R E  

1 - 6

Price of pizza, 

P

D

2 

D

1 

Q

1 

Q

2 

P

1 

P

2 

S 

Quantity of pizza, 

Q

S

2 

S

1 

Q

1 

Q

2 

P

2 

P

1 

D 

Price of pizza,

 P

Quantity of pizza, 

Q

(a) A Shift in Demand 

(b) A Shift in Supply 

Changes in Equilibrium

In

panel (a), a rise in aggregate

income causes the demand

for pizza to increase: at any

given price, consumers now

want to buy more pizza. This

is represented by a rightward

shift in the demand curve

from D

1

to D

2

. The market

moves to the new intersec-

tion of supply and demand.

The equilibrium price rises

from P

1

to P

2

, and the equi-

librium quantity of pizza rises

from Q

1

to Q

2

. In panel (b),

a rise in the price of materi-

als decreases the supply of

pizza: at any given price,

pizzerias find that the sale of

pizza is less profitable and

therefore choose to produce

less pizza. This is represented

by a leftward shift in the sup-

ply curve from S

1

to S

2

. The

market moves to the new

intersection of supply and

demand. The equilibrium

price rises from P

1

to P

2

, and

the equilibrium quantity falls

from Q

1

to Q

2

.

---

equilibrium price of pizza rises and the equilibrium quantity of pizza falls. Thus,

the model shows how changes either in aggregate income or in the price of

materials affect price and quantity in the market for pizza.

Like all models, this model of the pizza market makes simplifying assumptions.

The model does not take into account, for example, that every pizzeria is in a

different location. For each customer, one pizzeria is more convenient than the

others, and thus pizzerias have some ability to set their own prices. The model

assumes that there is a single price for pizza, but in fact there could be a differ-

ent price at every pizzeria.

How should we react to the model’s lack of realism? Should we discard the

simple model of pizza supply and demand? Should we attempt to build a more

complex model that allows for diverse pizza prices? The answers to these ques-

tions depend on our purpose. If our goal is to explain how the price of cheese

affects the average price of pizza and the amount of pizza sold, then the diversi-

ty of pizza prices is probably not important. The simple model of the pizza mar-

ket does a good job of addressing that issue. Yet if our goal is to explain why

towns with ten pizzerias have lower pizza prices than towns with two, the sim-

ple model is less useful.

C H A P T E R   1

The Science of Macroeconomics

| 11

FYI

All economic models express relationships among

economic variables. Often, these relationships are

expressed as functions. A function is a mathemati-

cal concept that shows how one variable depends

on a set of other variables. For example, in the

model of the pizza market, we said that the quan-

tity of pizza demanded depends on the price of

pizza and on aggregate income. To express this,

we use functional notation to write

Q

d

= D(P, Y).

This equation says that the quantity of pizza

demanded Q

d

is a function of the price of pizza P

and aggregate income Y. In functional notation,

the variable preceding the parentheses denotes

the function. In this case, D( ) is the function

expressing how the variables in parentheses

determine the quantity of pizza demanded.

If we knew more about the pizza market, we

could give a numerical formula for the quantity

of pizza demanded. For example, we might be

able to write

Q

d

= 60 − 10P + 2Y.